401(k) Outsourcing: A Risk Reward Analysis

401(k) Plans Outsourcing: How to Know If It’s Right For You

With a name that comes straight out of Internal Revenue Code, 401(k) plans are becoming an increasingly common, and incredibly complex, way of enabling employees to plan for their retirement. Though these plans have been around for some time, 401(k)s have recently come back into the spotlight thanks to the ever-growing number of companies looking to leverage this tool via outsourcing. It seems as though the level of financial and investment expertise that is required to manage these plans has prompted the outsourced option to become increasingly popular with employers who aren’t looking to deal with the expense (and trouble for that matter) of working to develop and retain in-house expertise. Yet countless numbers of companies have remained on the sidelines for years when it comes to their 401(k) plan and benefits administration—content to forever be debating the merits of outsourced versus in-house administration. Well, all that appears to be changing now though due to recent changes in the Employee Retirement Income Security Act 1974 (ERISA)—or more specifically the “prudent expert rule”; which mandates that retirement plans (401k or otherwise) must be outsourced to experts if the needed expertise can’t be found in-house.

Does Outsourcing My 401(k) Plans Net Any Real Benefits?

Even though compliance issues like ERISA may be breathing down the necks of employers and forcing some into the option of outsourcing before they’re ready, the fact of the matter is that there are significant benefits to 401(k) outsourcing. For example, cost savings, better outcomes, increased productivity, and more are all potential positives from outsourcing any benefits function. Not only that though, according to a recent article from Forbes magazine (401k Outsourcing: The Next Big Thing), a number of other benefits like liability reduction, increased service levels, a greater degree of objectivity, and fewer conflicts of interest can be had as well.

Will Outsourcing My 401(k) Help with Liabilities?

As with any program involving investments, the process of managing a 401(k) plan involves a certain degree of financial risk. As such, outsourcing the administration of that process can help reduce your liability. Even so, what really matters in determining your liability exposure is the role you want your outsourced provider to take on. For instance, do you want a plan advisor who offers objective advice (and is held liable) to your business’s owner or board of directors (i.e. the plan sponsor) and makes the actual investment decisions? If so, look for an Investment Fiduciary. Looking for someone independent who provides advice, but is also responsible for the selection, assessment, and disposal of investment options? If so, keep an eye out for an Investment Manager. And finally, if you want to take the whole process even further (effectively giving away total overall responsibility for 401(k)); seek out a Plan Administrator to take over operational control.

In much the same vein as payroll outsourcing, factors such as your in-house expertise, any requirements for control, and your organization’s size will inevitably dictate not only your decision to outsource but also the choice of fiduciary option. As the abovementioned Forbes report states, “small to mid-sized plans are beginning to outsource 401(k) fiduciaries”, and one of the options on the table for smaller businesses is a multiple employer plan (MEP)—essentially a setup where a single plan administrator and an appointed investment manager take over operations for plans for more than one independent employer. The benefit here is that you’re able to have cost savings passed down that are usually only available with larger plans.

What 401(k) Fees Are Associated?

While obviously the cost of outsourcing a 401(k) plan can vary markedly depending on the level of responsibility you’re outsourcing, oftentimes the fees associated with those plans can be less than transparent. To help you understand them better, think of these fees as falling into one of two broad categories: administration and investment management. With administration fees, you’re paying for record keeping, legal work, and accounting. Investment management fees on the other hand (the larger portion of the overall cost) cover everything else. Why does this matter you ask? Well, quite simply, the reason fees are so critical in 401(k) administration is that they can have a sizeable impact on the plan’s final value. For example, a July 2012 article on SmartMoney.com points out, “if fees [only] amount to 1% of assets, they [can wind up reducing] a 401(k) participant’s rate of return by about 25 percent.”

The current shake-up we’re seeing with 401ks (along with accompanying press and media commentary) is due to new rules from the Department of Labor mandating full disclosure of the cost of managing 401(k) plans. As of July 1st 2012, companies administering 401(k) plans must disclose to plan sponsors details of all associated costs. Furthermore, although sponsors isn’t obligated to pass on this information to plan participants, they do have to now provide expense ratios for investments offered by the plan, showing participants the charges per $1,000 invested (initial disclosures are due on August 30th 2012). The purpose of the disclosures is to help sponsors and employers to select and monitor plan providers more effectively.

Organizations should be cognizant though that one of the most common employee misconceptions is that 401(k) accounts tend to be cost-free; in large part due to the fact that traditionally the costs of administration were effectively obscured by the bottom line plan value figures. As such, this may mean that the first round of disclosures will bring employers a real (albeit brief) storm of discontent from participating employees. So, keep this in mind and keep communicating the fact that quarterly disclosures can only help in ensuring that your 401(k) plans are being managed effectively.

401(k) Outsourcing – final thoughts

Regardless of their relative size, an ever-increasing number of companies are starting to look long and hard at outsourcing their retirement plans either to a specialist service provider or to a vendor that offers some type of bundled HR, payroll and benefits package. Irrespective of your company’s direction though, there are key considerations to think about when shopping around for a potential solution provider. For example, you’ll want to discover the types of investments available you’ll be able to choose from. You’ll want to find out if any employee education will be offered. And (though it likely goes without saying) you’ll want to know up-front what the bottom-line price will be. The good news is that these new Department of Labor (DOL) regulations should make that selection process easier; and make it easier to harness quality information on which to base your decision.

Regardless of their relative size, an ever-increasing number of companies are starting to look long and hard at outsourcing their retirement plans either to a specialist service provider or to a vendor that offers some type of bundled HR, payroll and benefits package.”